Japan raises its consumption tax by 3% as real wages fall by 1.9%

1st April 2014 by The Harried House Hunter

Earlier today Japan entered a new phase for its economy because as midnight passed in April the 1st this happened. From the Yomiuri Shinbun.

With the start of the new fiscal year Tuesday, ordinary people are expected to face various changes to their daily lives, and the focus of attention is on the rise in the consumption tax rate from 5 percent to 8 percent.

The rise in the consumption tax, imposed when purchasing goods and receiving services, is the first since April 1997, when it was increased from 3 percent.

The impact of this will be felt by much of the economy as the newspaper goes on to point out. For example the price of posting a letter has gone from 80 to 82 Yen and the initial taxi fare in Tokyo has gone from 710 to 730 Yen. An intriguing side-effect has been that the Hiroshima mint has been producing one Yen coins again ahead of an expected increase in demand for them as prices change. This is rather awkward for Japan Inc as you see it costs approximately two Yen to make each one Yen coin! That is a major reason why production for general use stopped, but the coin remained in circulation because the Japanese have an emotional attachment to it. Although some have an attachment based in physics as it is exactly one gram of aluminium so it can be used as a measure.

What can we expect?

The Euro area saw a wave of consumption (Value Added Tax) increases and in response it saw falls in domestic demand and rises in inflation in what turned out for countries like Greece to be a very toxic mix. Will this be the same for Japan? This is what happened when the consumption tax was last raised (from 3% to 5%) according to the Wall Street Journal.

But after the government raised the consumption tax to 5% in April 1997, the economy sank into recession. The downturn would last for over a year and a half, helping deflation take root in Japan.

There were other factors at play such as the Asian financial crisis but whatever your view it is a disturbing portent as we note that this rise is of 3% and not 2%.

Inflation nation

There will clearly be a boost here as the Yomiuri Shinbun makes clear.

All 10 major electricity suppliers and four major gas firms in Japan will raise their rates for May to record levels to reflect a consumption tax hike and rising fuel prices.

The average price of liquefied natural gas in December-February, the base period for setting May rates, went up about 3 percent from November-January.

Indeed it would appear that Japan Airlines or JAL also got its retaliation in early.

Japan Airlines has announced it will raise airfares for its domestic flights from July 4 to Oct. 25 due to surging fuel prices and the weakened yen.

Airfares will increase by 1.5 percent on average, in JAL’s first hike for domestic flights in six years.

It is somewhat alien to more western eyes to observe a situation where the price of airfares had not risen for a sustained period! In a way this expresses the difference between Japan and the rest of the western world and many of you may be wondering exactly what terrors this holds? Remember Christine Lagarde of the IMF?

Now inflation in Japan is being pushed higher mostly by energy price rises due to the Abenomics inspired fall in the Yen. The latest numbers are below.

The consumer price index for Japan in February 2014 was 100.7 (2010=100), the same level as the previous month, and up 1.5% over the year.

Confirming my point the sub-sector for fuel, light and water charges was up 5.8% over the past year. If we move to the inflation rate preferred by the Bank of Japan – apparently central bankers either do not eat or at least do not pay for it – the annual inflation rate is now 1.3%.

The IMF has suggested this as a guideline for the inflationary impact of all this.

 For example, Mody and Ohnsorge (2007) find for the EU that a 1 percentage point increase in the VAT rate leads to a once-and-for-all increase in prices of between 0.26 and 0.42 percent.

So between 0.78% and 1.26% they estimate from this rise.

Turning Japanese?

Looking at the Japanese consumer inflation rate gives me a wry smile as it is now treble that of the Euro area! Are they doing this?

I’m turning Japanese
I think I’m turning Japanese
I really think so

I counsel caution on this as there is a major factor operating in opposite directions here. The Euro has risen and the Yen has fallen on the foreign exchanges and this explains much of the difference between the recent consumer inflation divergence between the two too. A year ago one Euro bought 120 Yen now it buys just over 142 Yen

As an aside Japan has its equivalent of the poundland and 99 pence stores and the largest is Daiso which is a 100 Yen store. It had switched to multiples of 100 Yen and (h/t Ben McClannahan of the FT Tokyo office) what were 200 Yen are now 210 Yen.

What about the deflationary impact?

This is in principle relatively simple as consumers in Japan will find that 3% extra will have to be paid on many purchases leaving them with less money to buy other things. Hence domestic demand gets a downwards push. We know from the experience of the Euro area that this can be a powerful influence. The IMF which is a fan of raising the sales tax has tried to rubbish this influence but of course its credibility was destroyed by its failures in forecasting such impacts in southern Europe. Actually there is a proliferation of media and official reports predicting how this will be a small impact and how Abenomics will triumph. Sadly for them this group does not appear to include Japanese businesses! The Bank of Japan Tankan released earlier has an expectations or diffusion index which has dropped 11 points since the December reading. Here is how Reuters summed it up.

The pace of decline in the Bank of Japan’s tankan sentiment outlook is more than the last time the government raised the sales tax in 1997, a central bank official said on Tuesday.

Wages are the key factor

The key factor going forwards is how wages behave as they will determine how the economy responds to the consumption tax rise. Indeed this is a big factor in how the overall Abenomics programme progresses. However this morning’s numbers are yet another disappointment as wages in February were 0.3% lower than a year before. We also get a clue as to how disappointing this series has been by noting the index was at 98.4 compared to the 100 of 2010.

We move to real wages with a heavy heart as we know that there has been inflation so it is no surprise to see that they fell in the year to February by 1.9%. This continues a long series of falls which the proponents of Abenomics told us would be reversed and in fact are currently telling us is being reversed. Perhaps they should speak to the statistics office and update themselves!

Actually if we look back on the data we see that so far Abenomics has been associated with sustained falls in real wages which is the doppelganger of what we were promised.

Comment

There is much to consider in the latest data and developments in Japan. The fiscal position combined with the demographics have placed it between a rock and a hard place. A shrinking population especially of working-age does not mix well with a national debt which last year passed one quadrillion Yen. Added to this Japanese governments have continued to run substantial annual deficits and Japanese tax revenues are internationally low.

So it looks easy that one simply raises the consumption or sales tax to help improve the public finances. The catch is that it weakens already troubled private finances and may give real wages another downwards push. If it does it will further damage domestic demand in Japan which was kind of where Abenomics came in. What we do know is that falling real wages are a problem for both individual Japanese and the overall nation. As we raise our gaze to the whole world where this is a common trend we have the troubling thought that this may be permanent.

Meanwhile if we look for echoes and clues for what may happen next then Markit have reminded us of what happened post the 1997 consumption tax rise.

By October 1998, manufacturing shipments were 8.6% lower than before the sales tax rise.

Inflation targeting

As we observe Japan inflation targeting from below the target -an unusual but increasing common situation- we can note (h/t Andrew Baldwin) that it began 26 years ago today at the Reserve Bank of New Zealand. So congratulations to my Kiwi readers! Although some may consider the date of the introduction to be appropriate.

 

 

 

 

 

 

 

 

13 thoughts on “Japan raises its consumption tax by 3% as real wages fall by 1.9%”

  1. forbin says:

    Hello Shaun,

    Does make you wonder if Abernomics was designed to ruin a once prosperous country doesn’t it ?

    Then again they did run a trade surplus but couldn’t run the Govt budget … sounds a little like USA and UK , well they joined us on the trade deficit .

    Run up taxes ? you need to make a surplus and bank the taxes raised to cover your debts

    no one ever seems to do this in the “western style” economics , ever since Romans times ? ( gold going to far Cathay for silk – oops china again! )

    So maybe its time to restart the Nukes, and as far as people go its balance you want, I mean if its just people per se why is India so poor ( pleanty of people there )

    As your work force shrinks then productivity needs to rise – Western style its quite obvious the only people making it are the top 01% , the rest can go hang.

    Like you point out , raise taxes reduce wages – doesn’t make for a consumerist economy …. more of a Brazillianization one. or Feudal “Dune ” style.

    Was there popcorn in “Dune” ?

    Forbin

    PS: Shaun if classic economics is not telling us whats going on – is this because the markets are “rigged” or shadowed ? Or do we have new theories now ?

    Or was LTG a blue print for the TPTB and not a warning ?

    sits back, grabs a bag , let the show go on …..

    1. Anonymous says:

      I predicted Japan would quickly restart the reactors. I was wrong.

      We know that Fukushima went badly wrong, and they had huge difficulties controlling/cooling the critical piles of uranium. They wouldn’t tell us about near misses – what don’t we know ?

      I don’t think they have completed a what went wrong and how we’d prevent it next time exercise.

      The nuclear regulators could arrange a quick response emergency generator team, with stockpiles of fuel and aerial transport in case of a future water cooled reactor emergency.

      1. forbin says:

        economically they need to start the reactor

        Engineering wise they have made and still are making from what I can tell a complete SNAFU of the situation

        I was surpised at first at the apparent non starting of the reactors but if you read up on whats happened – some taken with salt of course but always with the caveat that the secrecy level is high with these guys then I do wonder if what they found makes them $h!t scared of the next one……

        and yes I’m pro nuclear but with the caveat they you are dealing with the devil …….

        Forbin

        1. Anonymous says:

          Economically the case to restart is very strong. Makes me wonder what safety issues they aren’t telling us about ….

          I had a read thru the 4th gen reactor designs on the weekend. I was not convinced the new water cooled designs are any safer, they are just about cheaper power. VHTR Gas cooled is much simpler – no steam explosion worries, no loss of cooling fluid worries, no blockage worries, no pump failure worries, no void co-efficient management and no need for 100% guaranteed backup power supply. We need nuclear power and we need to design better than these water cooled time bombs.

    2. Anonymous says:

      Hi Forbin

      To your question I would reply that classic or past economics failed and has been replaced, by those who have thought about what has happened anyway! But it is also true that quite a few markets are now rigged and mostly by central banks.

      As to popcorn in Dune I do not recall it. However it is still getting more expensive as today the price of corn rose another 1%.

  2. dutch says:

    At least prices are going up there.The BoJ will be stoked.

    1. Anonymous says:

      Hi Dutch

      Actually it is troubled that people do not fully believe it will hit the 2% inflation target. It published a working paper on inflation expectations last week with this in it.

      “Nevertheless, relatively few market participants forecast inflation of 2% and the mean of 10-year expectations remains below the “price stability target of 2%.”

      This theme is also in the speeches from BoJ Board Members which often imply a close but no cigar line…A bit like the fact that it has got 1.3% inflation (excluding food) so far but not 2%.

  3. Anonymous says:

    Is Abenomics the cause of inflation and currency weakness ? or is it just coincidental to the timing of the balance of trade deterioration and increased energy import costs ?

    1. Anonymous says:

      Hi ExpatInBG

      If you look at the way that the Japanese Yen weakened after it became apparent that Shinzo Abe was going to win the election I think that it is pretty clear that it was the driver. Although of course we never can be absolutely sure. But in Japan there is still little private sector inflation.

      After the Great Eastern Earthquake and the higher energy costs implied by it there was no effect. In fact if anything the Yen rallied back then.

      Of course now it is all enmeshed with the trade deficit -which the Japanese will not like- and the energy costs issue…

  4. Rods says:

    Hi Shaun,

    Abenomics reminds me of US cartoons of my childhood. When the character runs off cliff and carries on running like nothing has changed. Then inevitably gravity takes over along with the realization of their predicament and you see them trying to climb in air back up the cliff, the climbing up the cliff part is Abenomics. Eventually…, well all know what happens when the said character reaches terra-firma!

    The reality is that spiraling government debt is beyond the point of no return, all they can do is try to inflate it away, by pumping up the volume and in my view this can kicking exercise will fail.

    Apparently, gold sales are doing very well at the moment where there will come a point when a kilo of 1 zillion Yen notes in one pocket will be worth considerably less than half an ounce of gold in the other.

    Countries can end up so awash with debt, that even having the ability to print whatever it takes will make no difference, as the smart money leaves or has left along with many businesses and is any canny investor going to invest in an economic basket case, before the reset button is pressed?

    1. Anonymous says:

      Hi Rods

      The Japanese situation is an example of what Winston Churchill called “It is a riddle wrapped in a mystery inside an enigma”.

      If we look at the Japanese Government Bond market we see a national debt of around 230% of GDP combining with a ten-year bond yield of 0.61% which shouldn’t coexist but it does. If we explain it by saying that the Japanese mostly buy their own bonds we now have the problem of inflation at 1.5% and inflation expectations which are now more positive. So again the JGB 10 year yield should not be 0.61% but we know it is.

      Your cartoon analogy is a good one and I too saw plenty of these plunges off a cliff as a child. However the cartoon characters usually survived one way or another didn’t they?

  5. Paul C says:

    Shaun, it would seem the land of Nippon has got it right. the Government raises price/tax and in concert tells all the major suppliers to raise their product and service selling prices then when you add up all the totals at the end of the year……. hey presto GDP has gone up, more has been taxed and shipped ( in money counting terms). Could be the reason for yesterdays’rosy UK numbers, it is all up everywhere!

    N.B. except real output.

    1. Anonymous says:

      Hi Paul C

      I tend to share your suspicion that the way that officials and many economists treat low inflation hints that they are keen on it being high enough that they can slip some of it into (claimed) economic growth…

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